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July 2, 2013

DeLegge on ETFs’ Future, Spat With Bogle, as ETF Conference Nears

Inaugural advisor-centric ETF gathering July 23 will provide advisors with the knowledge and tactics to successfully build client portfolios with ETFs

The growth in usage and assets of exchange traded funds has been both steady and spectacular. While ETFs can be used by active traders and buy-and-hold investors alike, advisors are increasingly using ETFs in client portfolios.

In its June 27 monthly report, the ICI counted $1.48 trillion in ETF assets in May, up from $1.1 trillion in May 2012, a rise of 37%, invested in 1,200 different ETFs (the first ETF, the SPDR, was introduced in January 1993).

While the cost- and trading efficiency of ETFs, and the ability to expose clients to broad or narrow swaths of the markets is well known, what’s less widely understood is how advisors can build efficient portfolios that meet client needs. According to a Cerulli survey released in May, advisors expect to increase their average allocation to ETFs this year. The survey found that of those advisors using ETFs, most use only a couple of ETFs at most for their clients, and the survey authors warn that even for those advisors who do adopt ETFs, it’s “highly unlikely that they will move to solely using” ETFs and abandon other investing vehicles totally in their client portfolios.

That’s why the editors of AdvisorOne and Investment Advisor and Research magazines are presenting our first ETF virtual conference on Tuesday, July 23. This free event (advisors must register to attend) has already attracted nearly a thousand registrants, with featured speakers like Gary Gastineau, Rick Ferri, Skip Schweiss and keynote speaker Ron DeLegge (left), along with ETF experts from Morningstar, New York Investing and AdvisorShares.

Moderating each of the six sessions (attendees can attend one or all of the sessions, as they wish) throughout the day will be editors from AdvisorOne, Investment Advisor and Research. Moreover, since this is an advisor event programmed by editors, we’re also including a number of your advisor peers who will share with the audience how, when and for which clients they use ETFs (CFPs can also earn up to five hours of CE from the conference, preapproved by the CFP Board of Standards).

So what is the state of the ETF industry, and what is its future? What are advisors doing right, and wrong, when it comes to using ETFs for their clients’ portfolios? Is it a question of either/or when it comes to ETFs or index mutual funds?

We asked keynoter Ron DeLegge, editor of ETFGuide.com who has written about ETFs for Research magazine for nearly a decade, to set the stage for the conference and to describe the environment in which advisors are using ETFs for clients.

Q. Could you give us a sneak preview of your keynote speech? What will you focus on?

A. What I want to focus on is the dynamics of how ETFs have revolutionized the way we manage investment portfolios, but also how advisors can manage their businesses for the next phase of asset growth by building a consistent approach to portfolio building—like Starbucks has done for coffee and McDonald’s for hamburgers.

There’s no reason for advisors to be inconsistent, while being efficient cuts operational risks, creates business efficiency and allows advisors to grow their practices by being in front of prospects instead of being in front of a computer screen, hand-constructing portfolios.

Q. What is the current state of the ETF industry? What can we expect in terms of new products? Will iShares, SSgA, Vanguard remain the dominant players?

A. There are almost 1,300 listed ETPs, managing $1.5 trillion across 18 different managers. Yes, there's been an increase in ETF upstarts, but 83% of ETF assets are controlled by the big three. That means 35 sponsors are competing for the remaining 17%, including most active [ETF] managers. The ETF marketplace has been focused too much on the next great vehicle; it’s good to be an innovator, but the real money is in distribution.

ETFs are a microcosm of what’s occurred in the mutual fund business where, driven by marketing, there are too many mutual funds. The number [of ETFs] is too many, but that won’t stop product developers.

For advisors, we’ve seen asset growth in ETFs for nine out of the past 10 years. So ETFs are now a mainstream movement, and clients are much less likely to look at them oddly when the advisor talks about ETFs, but there’s also more confusion today than there was a few years ago.

Q. How are advisors using ETFs, and how are they misusing them, in client portfolios?

A. I think advisors are successfully using ETFs as individual stock and active mutual funds replacements. They're also [using ETFs] to capitalize on major investment themes, such as faltering performance from [emerging-market] stocks; we’ve seen that play out this year.

Some advisors are using ETFs effectively, but not enough advisors are using index-based ETFs as core positions, rather than satellite. It’s befuddling to me; look at performance in the last five tumultous years. Look at core mutual funds, which have been devastated by ETFs; over 75% of large-cap actively managed mutual funds have underperformed the S&P over the past five [years]. Mid-cap funds? 80%. Small-cap mutual funds performed even worse; 90% have underperformed. The last five years have totally debunked the claim that active managers outperform the markets, especially in smaller-cap funds. Advisor have to align portfolios with the facts, rather than fairy tales and myths perpretrated by fund marketers.

Q. Is that behind your dispute with John Bogle?

A. No, that's a separate issue. He’s blaming ETFs for behavioral reasons, [saying] the problem with knives is that they cut too many people, or water is dangerous because people drown, or let’s eliminate cars because of car crashes. His argument is that because of the massive trading volume of ETFs, it hurts buy-and-holders. He has since admitted that there are ways to use ETFs in portfolios. And by the way, you can’t buy and hold forever; we don’t live forever. ETFs give you intraday liquidity, a flexible option — we shouldn’t demonize the feature of that product. Bogle and I still disagree, but our philosophies about indexing — we’re 100% on the same page on that. Our disagreements are completely respectful.

Q. Finally, when will we see adoption of ETFs in defined contribution plans like 401(k)s? What will be the catalyst?

A. The catalyst will be similar to the development of the e-reader and the e-book. We’ve had tablets since the 1980s, but it was only recently that breakthroughs with ipads and Kindles upended the publishing business. So who are the biggest beneficiaries of this movement? The ones who are early to the curve.

The lesson for ETF-focused advisors is be five minutes early rather than 10 minutes late; now is the time to prepare your businesses for this trend, to team up with technology providers and forward-thinking TPAs who are embracing this movement, rather than defending this dying legacy; align your businesses with ennablers who embrace this movement.

The catalyst is to educate yourself as an advisor as to who these technology providers are, how to plug your businesses into theirs and vice versa. Advisors can’t do this alone; you'll need to plug into partners, a team of enablers, like technology and fund companies.

Q. Will advisor custodians have a role to play?

A. Custodians are important to the mix. Schwab has been planning it for the last couple of years—an ETF(k) platform, which might force other custodians to come up with a solution. Schwab could be like Apple with the iPhone and iPad. They’ve got their own branded ETFs, so it's a natural fit. I’d like to see Schwab take their time and get it right, rather than rush and get it wrong, but they’ll be a force to be reckoned with. It could be the same thing they did with the [OneSource] mutual fund marketplace by applying the same methodology to the ETF market.